Ah, writing off business expenses. The allure, the luxury, the… confusion?
Often when thinking of a standard business expense, the same image comes to everyone’s mind… charging a lunch on the company card. Hey, who doesn’t love free lunch? I know I do.
But, business expenses are much more involved than a “free” lunch here or there.
Are you confident that you understand the details of how business expenses could work for your company? If you aren’t, you’re not alone. Many Apparatus clients are a bit confused by the topic, so we thought it would be worthwhile to spend a little time talking it out.
The reason that IRS rules allow a small business to write off business expenses is that at least in theory, your obligation to the IRS is to pay taxes on net income….the money that is left over when you start with gross sales and subtract all business expenses related to generating those sales.
The IRS is also trying to encourage certain kinds of behavior. The IRS recognizes that it is in the interest of small companies to take risks and to make purchases that ultimately enhance the growth of a business. So, business expenses can include things such as marketing costs that may not have an impact on the sales you generated in this tax year, but may be the source of future sales in future tax years.
But, you can’t just write off anything that seems like it might be a legitimate business expense. Meeting with a client and paying for lunch? You bet.
Buying accessories for your work vehicle that have nothing to do with work? That’s a great example of where things get a little murky.
The key test is that purchases you make for your business may be “expensed” or written off as a cost against this year’s sales if the expense can be considered to be both “ordinary” and “necessary”.
An ordinary and necessary expense would be one typical to your industry that is important for your business operations. Some examples would include protective gear for a roofing project, employee salaries, or the gas you buy for your work vehicle. Even a new work vehicle for your growing team can be a deductible expense, but the IRS has rules for how much of the cost of that new truck you can “expense” in a given tax year. That’s a topic for another blog post.
If you’re ever uncertain about what you can and what you can’t charge to your business, consult your CPA or check out the IRS’ very own list of business expenses they deem as deductible.
Don’t forget that there are costs you may be incurring that you may not realize are considered a legitimate business expense. A great example is mileage on your family car that you use every now and then to visit a potential client or to run business-related errands. The IRS allows you to deduct 53.5 cents per mile for every mile that you put on this non-work vehicle, but only if you keep a mileage log and record the distance and purpose of each trip. If you aren’t making note of these kinds of expenses and charging them to your company, you’ll overstate your taxable income and pay more in taxes than you owe.
You should make certain that you keep detailed, itemized receipts for all your business expenses. And, you should plan to keep them for not less than seven years in case your company gets a visit from the IRS and you need to defend your decisions during an audit.
Keep receipts organized by month and year and place them somewhere that is safe and secure. By far the best way to store them is in the form of a digital cloud-based archive with automatic backup. Digital filing is the quickest, easiest way to keep important documents. It also makes these documents searchable and within reach anywhere you go.
If the discussion above is old news to you, congratulations – you’re ahead of the game and you should feel great about being organized and playing by the rules.
If the discussion above makes you a bit seasick, you’re not alone – most contractors struggle with this kind of detailed bookkeeping and records retention.
Not yet organized and want to get started? Our team is always ready to answer your accounting and expense questions.